Demystifying Reverse Mortgages and How to Potentially Use them for Investment Purposes

A reverse mortgage is a financial tool that taps into the equity of one's home, enabling homeowners aged 55 and above to reside in the property without making monthly mortgage payments. Here’s how it typically works:

Clients can access anywhere from 25% to 59% of their home’s value, and they have the flexibility to receive the funds either as a lump sum or over time.

For example, consider a property valued at $1,000,000 with a $300,000 mortgage at a 6% interest rate. Each year, the interest accumulates, adding 6% of the mortgage’s balance. Despite this, real estate typically appreciates by around 3% annually, which can help offset the interest charges. After the first year, the property’s forecasted value would be $1,030,000, while the new mortgage balance would be $318,000. This demonstrates how property appreciation can offset increases in the mortgage balance, making reverse mortgages attractive for those seeking to live mortgage payment-free while using their funds for other endeavors.

One common use of reverse mortgages is for individuals wishing to enjoy their retirement without financial strain. They can utilize the additional funds to enhance their quality of life or pursue personal interests. Another application is for clients with substantial equity who want to leverage it for investments, such as purchasing a vacation home or starting a business.

While reverse mortgage interest rates may be slightly higher compared to traditional loans, they offer valuable benefits. Clients can choose to make interest payments or allow the interest to accrue until the property is sold or refinanced.

A common misconception is that the lender will own the property. In reality, the lender holds a mortgage lien on the property, similar to any regular bank. If you're considering a reverse mortgage, remember that it functions like refinancing your home; any existing mortgages or liens must be paid off with the reverse mortgage funds.

Overall, reverse mortgages can be a viable solution for individuals aged 55 and above with substantial equity in their property, seeking to reduce monthly expenses or finance other projects.

How to Use a Reverse Mortgage for Investment Purposes

Once you understand what a reverse mortgage is, you can see how it can be used for investment purposes. When a mortgage is used to finance an investment, it's important to note that the gains from the investment will be taxable. However, any associated costs, including interest from financing, will be tax-deductible.

With a reverse mortgage, even though the homeowner isn't making monthly payments, interest is still accruing. Therefore, one potential strategy is to obtain a reverse mortgage to buy a rental property, which can help with cash flow. While a reverse mortgage can only be placed on a principal residence, you can use the funds to purchase a rental property. As long as you maintain a clear audit trail showing where the funds came from, that portion of the mortgage can be tax-deductible.

When it comes to taxes, it’s essential to understand the balance of revenue and expenses. If you’re taxed on your rental income, you can deduct the expenses, including the accrued interest from the reverse mortgage. This strategy is especially beneficial for homeowners with significant equity who may not qualify for traditional financing or who want additional cash flow.

For example, if the market value of your principal residence is $2,000,000 and the lender allows a 25% loan-to-value ratio, you could potentially access $500,000 through a reverse mortgage. This amount could be used to buy a condo or rental property. If you choose not to mortgage the new property for cash flow reasons, you would receive rental income without the associated mortgage expense. The interest on your reverse mortgage would still accrue on your principal residence however can be tax deductible if it’s not ‘contaminated’ meaning you show that the interest expensed derive from funds directly used to purchase the investment tool.

When you file your taxes, you would report the rental income minus the interest expense, allowing you to keep more cash flow available. If you have equity in your property and are interested in investing in rental properties, this is one effective strategy to consider.

For any questions, please feel free to contact us. Remember, #FinanceWithLuigi always has a solution tailored to your needs.

Luigi Iafrancesco, CPA

Courtier Hypothécaire - Mortgage Broker

Groupe Hypothécaire Orbis inc. / Orbis Mortgage Group inc.

285 Place d'Youville, Montréal QC H2Y 2A4

t: 514-983-7509 f: 1-888-570-2755 e: [email protected]

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